I asked several of my coworkers who they think is the world's largest manufacturer of rubber tires. The responses were what you would have expected – Goodyear, Firestone, Bridgestone, Michelin, etc. Yet all of these manufacturers pale in comparison to the top rubber tire producer by volume: The Lego Group.
Lego produces 306 million rubber tires per year[1]. The Danish company has been producing toys — and lots of rubber tires — since 1932. Chances are good that you and the children in your life have owned and played with those tires.
Granted the Lego tires are small but they are rubber tires.
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Our frame of reference often leads us to decisions that may not be entirely correct. I recently experienced a similar situation with some comments about an Employee Stock Ownership Plan. A company owner emphatically stated that he would "not give away the company to the employees" with a particular emphasis on the words "give away."
His concerns are understandable. He's worked all is life to build a successful business and he doesn't want to just give it away. But he suffers from a common misperception. While an ESOP does transition ownership of all or part of the company to the retirement plan on behalf of the employees, it isn't given away. The owner is compensated for the shares and employees "pay" for them through sweat equity. The harder they work, the more the company grows, the greater the value of the shares distributed to employees through the retirement plan.
ESOPs are sometimes thought of as giving the company to employees because typically employees do not contribute financially to the retirement plan which holds the ESOP shares. The plan is funded solely by the company. But in many ways an ESOP is similar to selling the company to a third-party.
When a business owner decides to sell to a third-party rather than an ESOP, the third-party typically goes to the bank and secures a loan to purchase the company. The loan proceeds are used to pay the selling shareholder for their shares. The new owner then repays the bank loan using future cash flows from the acquired company.
When the owner decides to sell to an ESOP, there are multiple ways to structure the transaction but a common approach would be to borrow the funds from a lending institution and use these borrowed funds to acquire the shares from the selling owner. The company then repays this loan from ongoing cash flows. As the loan is repaid, shares are allocated to participant (employee) accounts. One of my blog posts goes into much more detail about how an ESOP is formed.
The net result to the owner is very similar. The company is sold and the owner is able to transition out of the company and trade ownership for liquid assets. But the impact to the company and the employees is dramatically different and is heavily influenced by the differences in tax treatment between the two approaches. More on that in a future blog.
Lego is the world's largest manufacturer of rubber tires and ESOPs do not give away the company to the employees. This blog will continue to examine misconceptions regarding ESOPs. If you have an area you would like to see addressed, drop me a comment and we will try to work it in.
Company stock is not a pooled investment. Stock may experience greater volatility and should not be directly compared to investment options that have a more diversified investment mix. It is not intended to serve as a complete investment program by itself.
Insurance products and plan administrative services are provided by Principal Life Insurance Company a member of the Principal Financial Group (The Principal), Des Moines, IA 50392.
[1] Pisani, Joseph. The Making of…a Lego. Bloomberg BusinessWeek, November 29, 2006
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